Stefan Stübing Dr Gohar Sargsyan
Making the case for sustainability
To set the scene, we should remember that the surface temperature of the Earth is rising at a record pace, which creates high risks for life, nature and business. In this uncertain environment, banks play a crucial role helping to finance a green agenda whilst managing their own financial balance, leading to mitigation of the impact of global warming. You may like to (re-)visit the following sources about sustainability from the authors’ organisations and own work .
Globally, there are a number of initiatives in place, the most remarkable being the 17 Sustainability Development Goals (SDGs) . In Europe there are additional goals and policies towards the Green agenda, the most notable being the EU Green Deal with approximately 1 trillion EUR budget by 2050 . There are also national initiatives - one of the exemplary cases set by the Australian government . Why does this matter? The effects of Climate Change are clearly evident, particularly in Australia. These demonstrate the urgency of the matter and the actions being taken to regulate the impacts of Climate Change besides voluntary initiatives. However, do we have a realistic plan? Do we have the right instruments, tooling and knowledge to deliver on SDGs and prosper? What does it take to make this work for the benefits of all? How should the financial industry align to streamline efforts? Banks are in the forefront of all these initiatives as orchestrator of major capital flows, with ABN AMRO being a serious driver, showcased i.e., by co-founding the Partnership for Carbon Accounting Financials (PCAF) initiative – an industry led partnership responsible for leading the progress towards achieving the mission and objectives of the Paris Climate Agreement in the financial industry .
Rules and Regulations shaping the game
Multiple rules and regulation are set at different levels: global, European, national, local and even in some cases at company level. Banks and businesses face enormous challenges with regard to compliance of all regulations and procedures set for sustainability. To name a few, In March 2018, the European Commission introduced its Action Plan on Financing Sustainable Growth, defining the EU strategy on Sustainable Finance and laying a foundation for future work across the financial system in the EU, including the EU taxonomy for sustainable activities , which has been set as a common classification system for sustainable economic activities. On February 25, 2022, the European Commission launched a new Corporate Sustainability Due Diligence law proposal, which will have the most impact on corporates and banks by 2025 onwards with the main goal to increase Supply Chain Integrity .
Challenges and how to overcome
Finding challenges for the sustainable transition comes easy, already underpinning a dilemma for all transition agendas, independent of geography. In the perception of many, it comes down to trading personal / national (depending on perspective) wealth - assuming that it costs to facilitate change - against social / environmental wealth – assuming societal benefits from own “sacrifice”. What is often forgotten in this thought process is the opportunity costs, which are neither precisely predictable nor certain with regards to timing. So, the direct impact is hard to assess without having sufficient knowledge, so that analysing sustainability risks is not trivial.
From a bank’s perspective, we currently see three major challenges institutions need to overcome in order to succeed in the Sustainable Finance discipline:
1. Lack in market alignment
Subjectivity as result of information bias or misalignment on sustainability. High ambitions require mature, thus efficient markets. Regulation plays a crucial role in creating an even playing field based on consistent frameworks to leverage investments in sustainable assets and companies in a consistent environment, leading robust and transparent mandates around Sustainable Finance.
2. Lack in data availability and consistency
Gathering sustainability-related data (“ESG data”) on a wide scale in companies is still a relatively new discipline. Although the majority view in scientific research is that ESG performance is positively correlated with company performance, ESG ratings are still relatively new and still highly subjective (different providers have different methodologies so there is little comparability). The implication on other risk factors as drivers of financial risk which may materialise in credit risk, operational / non-financial risk, market risk and liquidity risk needs to be embedded in integrated Risk Management Frameworks. Further, you need to establish access to material and consistent data around ESG, which is a challenge in itself.
Just recently, Elon Musk shocked the ESG movement with his Tweet saying “ESG ratings make no sense”, perfectly illustrating the described issue at hand . The ESG framework requires deeper understanding and interpretation. A sustainable business solution provider (e.g., Tesla producing electric vehicles) might fall short in ESG rating scores to less solution-oriented peers (e.g., VW or Mercedes) or even companies operating in non-sustainable or even damageable areas (e.g., British American Tobacco). One might argue, how can that be? That’s because the ESG framework looks at ESG risks associated with business operations of the company and NOT necessarily on its positive / negative impact on the world. Furthermore, there are several different standards for modelling ESG data and translating it into KPIs, scores or ratings that are difficult to compare. So, what does this actually mean?
ESG is not equivalent to impact, full stop. However, impact can be measured via ESG-related data if utilised in the right manner (e.g., via evidencing GHG emission reductions resulting from green investments by a company). So, when reading an ESG rating report, a high score (or alternatively low) is not necessarily linked to a strongly positive (or alternatively negative) sustainable impact on a wide scale.
This in result makes the assessment of relevant ESG performance challenging not only for investors and companies but also banks that need to factor those in their credit decision making process.
3. Run on talent / Understanding the ESG impact
Sustainable Finance is a rather new discipline in mainstream finance, which is challenging existing patterns and strategies. Climate Change as a major megatrend is not only disrupting certain industries, but entire ecosystems. It challenges the globalised world in a radical way and also has (geo)political implications. The Financial industry is deemed as essential for efficiently channeling investments to sustainable friendly assets and companies. In order to do so, fresh blood is required in the institutions in a field where senior talent is almost non-existent. So, an industry, which was in the past (and probably also today in certain areas) been known for dodgy business ethics and practices shall now attract highly motivated and talented people in the area of Sustainability.
The leading consulting group in the area of talent acquisition, leadership and professional development, Korn Ferry, identified a significant talent gap around ESG with the right transferable skills and expertise to help achieve ESG goals and to make a difference during their panel speech at the Conference of Parties 26 in Glasgow 2021. Panel contributor Dr Nicola Crawford identified a significant leap in sustainability roles, noting a gap in matching skilled people into these roles .
Solution pathways to overcome identified challenges
1. ESG Data centricity (cross sectoral collaboration and external data providers)
Getting access to the right ESG data is like the search for the “holy grail”. The double materiality (inside-out / outside-in perspective) makes data modeling around ESG data complex. Further predictions on impacts from performance around ESG remains difficult (Sustainability risks can materialise over the short term (directly), medium term (1-5 years) or long term (5-30 years) after environmental, social or governance issues occur. The risks can materialise both during and after the issues occur). In order to steer portfolios efficiently consistent data strategies are essential, but require openness on technologies / providers.
2. ESG servitisation and holistic ESG stewardship
Connected platforms providing ESG data via hubs and tailoring intelligence for individual purpose for ESG data (e.g., connecting suppliers, banks, authorities, manufacturer, etc.) would allow for efficient ESG stewardship, making sure that all stakeholders can rely on consistent data. However, in a capitalist world where data ownership means power, this sharing concept is not easy to establish. Furthermore, collaborative efforts both inter and cross-sectoral (leveraging the ecosystem idea) becomes essential for future success. In a first stage, banks might have an edge given they already execute an intermediary role, so that they are a logical landing spot for ensuring certification / verification function also on sustainability.
Sustainable Finance to deliver on Climate Change
There is a need of fundamental reshaping of finance around a new financial model, which we call Green Finance, or the practice of financing sustainable, environmentally friendly investments, or Sustainable Finance. Sustainable Finance refers to the process of taking environmental, social and governance (ESG) considerations into account when making investment decisions in the financial sector, leading to more long-term investments in sustainable economic activities and projects . Sustainable Finance will reduce exposure to assets and organisations that may soon become untenable due in part to the physical effects of Climate Change. Investing in Biodiversity is the next business case for the banks. A recent study by the Dutch Central Bank, in cooperation with the PBL Netherlands Environmental Assessment Agency, released that the Dutch financial institutions are collectively exposed to around EUR 510 billion in risk from companies highly dependent on ecosystem biodiversity . An example from insurance companies, is that a world with 4 to 5 degrees of warming would be “uninsurable” . Another aspect is how financial institutions and the businesses they support can seize a competitive advantage by proactively addressing “transition risk,” which stems from assets and organisations that will inevitably lose market share when Climate Change impacts consumer preferences. Combining these factors with regulatory pressure, lack of mature sustainability skills, internal employee support, and shifting consumer requirements and expectations, are increasing the need of a new and sustainable financial system that deploys capital towards low-carbon, resilient investments.
The role of IT companies
The role of technology companies is critical in enabling and accelerating the decision-making process of financial institutions in Green Finance. IT companies are also at the forefront of designing new platforms, data centers, services and solutions, migrations, not only as enablers but also by applying a Green IT approach, making double the impact on sustainability metrics. If approached from a sustainability perspective, the IT solutions and migrations can deliver a double helix effect of shareholder and stakeholder value: simultaneously reducing costs and carbon emissions. IT companies can be fundamental in leading to a greener planet and a boost in profitability . The need of comprehensive data platforms from customers and their sustainability performance will play a critical role in the transition and decision on who should receive Green Financing and sustain in business.
Leveraging on ESG data centricity
Is the customer data reliable? Customers also face similar sustainability challenges as banks. ESG reporting and being compliant to regulations and standards are for all corporates. How can the bank be sure that the customers provide fully accurate information on their ESG reporting? It is a challenge for the bank to inspect and conclude independently each customer’s case, being exposed to the risk of falling in “greenwashing trap”.
By nature, banks hold an enormous amount of structured and unstructured data that is analysed and processed. In terms of ESG (risk) impact, banks are typically most focused on credit (risk) related data as result of credit risk forming banks’ greatest potential risk. With banks showing relatively high or low exposure to carbon-intensive sectors score comparatively well. This is assessed to be result of a risk-based approach, meaning that banks facing the greatest potential risks started incorporating ESG earlier, while those with relatively limited risk believe less effort is required as result of their materiality profile . This illustrates that the perception of banks in the ecosystem might shift in certain areas from “data collector” to “data user” in areas where data quality cannot be safeguarded internally.
Accordingly, banks could become a trusted party that get access to ESG data collected by a reliable party (i.e., a platform) bringing together the data needs of the most commonly used frameworks, initiatives, and regulations. ESG data services become a separate business model that allows consuming and re-occurring information requests by all sorts of data users (with banks being one of them next to e.g., suppliers, investors or clients of banking clients) to leverage on standardised and comparable ESG information with multiple stakeholders in one place, in a cost-efficient manner. This - allowing for seamless integration in own data and quantitative risk modelling - in combination with tailored offerings targeting a comprehensive customer experience, with seamless integration of financial services into corporate requirements, allows for taping an ecosystem of partners with banks leveraging on their credibility as a trusted third party while executing the intermediary role.
Customer incentives could be applied, which might include
- knowledge exchange: joint workshops to learn from each other how to improve sustainability performance
- competition and potential prize award: among the categories of customer profiles, regarding to sustainability-based competition can be organised and the winner(s) can get recognition and award
- discounts on certain services or products: can be directly applied towards ESG performance of companies 
- elevating profile: banks can publicise customer collaboration with customers who tick all the boxes and demonstrate strong commitment. All these lead to a new form of relationship between the customer and the bank, which is a type of partnership and collaboration.
The key to success in the Sustainability journey for the banking sector
Achieving an inclusive economic system and the Sustainable Development Goals (SDGs) requires effective multi-stakeholder collaboration for all sectors. This is because no single entity is in control of the complex issues that need solving; collective action and systems leadership is required to move forward. The Banking sector is no different from the perspective of the need for partnership and collaboration. We strongly believe that leveraging partnerships and collaboration to achieve sustainability goals of the bank is a valid solution, both internally and externally. Internally employees in the organisation need to believe the value and the impact of sustainability on their lives, society and business to be motivated to contribute. Externally the multi-stakeholder partners including customers and suppliers need to come together to solve complex sustainability issues. A cross-border, partnership approach is key to developing emerging talent and giving them the skills to drive and achieve ESG-related goals, which are essential for scaling ESG compliant portfolios. Sustainability leaders need certain skills to succeed. If a business does not actively promote qualified sustainability leaders - innovators who will take risks, challenge the status quo and ask the difficult questions - they certainly fall short on set ambitions. Thus, we are convinced that partnership and collaboration is a key enabler towards the successful implementation of the Sustainability Agenda in the Banking Sector.
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 There are two relevant perspectives when referring to sustainability risks (double materiality concept):
- Inside-out perspective (social and environmental materiality): This perspective relates to the impact that the Bank – through its clients – may have on society and environment. This impact may translate into a financial impact on a client’s value. This perspective is taken into account by the incorporation of sustainability assessments in the due diligence of the Bank.
- Outside-in perspective (financial materiality): This perspective relates to the impact of ESG factors on a Bank’s activities. This refers to the financial impact of ESG factors that manifests through established risk types. For example, the financial performance of a client may be affected by ESG factors and thus translate into elevated credit risk
 ESG data provide information on companies’ performance in terms of ESG factors. Initially referring to upstream raw and processed data points reported by companies, the term ESG data also considers measurements and statistics selected and calculated based hereon. Consequently, this captures also downstream ESG KPIs, ESG scores and ESG ratings as outcome of processed data.